A key issue facing businesses and investors is whether the US January data reflects a reacceleration of the world's largest economy or whether it was mostly a payback for extremely poor November and December 2022 data and seasonal adjustments and methodological distortions. Given the centrality of the US economy and rates, it is not simply a question for America, the Federal Reserve, and investors, but the implications are much broader. The issue is unlikely to be resolved in the week ahead, but it may begin pointing to the direction ahead.
To believe in the now much-touted "no-landing" or "soft landing scenario" requires the bold and dangerous claim that this time is different. That the inversions of the yield curve, including the 3-month bill and its 18-month forward, which Federal Reserve Chair Powell cited partly to play down the earlier inversion of the 2-10-year curve, do not mean what they have in the past. The roughly 7.0% decline (annualized pace) of the index of leading economic indicators is giving its first false signal in a half-of-a-century. The rise of business failures, the rising default rate on car loans, and the tightening of lending criteria can be largely ignored. While this is all possible, it seems patently unlikely. Expect the February data to begin casting shade on the January-spurred optimism.
US: Our working hypothesis is that the January data will not be repeated. It was mostly a function of a bounce back from dismal November and December activity and a statistical quirk caused by benchmark, methodological, and seasonal adjustments. February data are going to look considerably softer. It already seems apparent in some survey data, including the Philadelphia Fed's February business activity outlook and the preliminary PMI. The January reports next week include durable goods orders and the advanced merchandise trade balance. They pose headline risk. More importantly, will be the ISM February services. The January report was released shortly after the employment data, and the intraday charts from that day (February 3) suggest services ISM spurred the outsized market reaction. Auto sales, which do not receive the attention they ought to, perhaps due to the manner of release (companies report throughout the session), are expected to pull back by almost 5% after surging by a little more than 18% in January. The early estimates for February non-farm payrolls (March 10) are 200k. After the revisions, the average monthly jobs growth last year was 401k. The Treasury sells only bills next week; no coupons and the schedule of public appearances of Fed officials is light.
The Dollar Index is closing in on last month's high near 105.65. Above, there is the 106.00-50 area that houses the (38.2%) retracement of the sell-off from last September's high (~114.80) and the 200-day moving average. The momentum indicators are stretched but have not begun to turn. Initial support now is in the 104.50-60 area.
Japan: The market is continuing to game out the possibility of a surprise by Bank of Japan Governor Kuroda at his last board meeting on March 10, shortly before the US (and Canada's) employment report. After being surprised in December (by the widening of the 10-year yield band) and February (no action), no one wants to be surprised again. The most important high-frequency data in the coming days will be the February Tokyo CPI, which offers important insight into the national figures, which are reported will cause a longer lag. We have warned that a combination of the appreciation of the yen on a trade-weighted basis, the drop in energy and wheat prices, and government subsidies should see inflation begin falling soon. It could start with the February readings. BOJ Governor nominee Ueda told the Japanese Diet the same thing before the weekend. Ueda clearly signaled no immediate substantive policy change. A Bloomberg survey found 70% expect a rate hike by early Q3. Two other observations are notable. First, the divestment by Japanese investors of foreign bonds continues to be discussed, but so far, they have been net buyers and replaced about 20% of the bonds sold last year. Second, the correlation between changes in the exchange rate and the US 10-year yield has continued to tighten after falling sharply in December and January.
The dollar posted a bullish outside up day ahead of the weekend, sparked by Ueda's seeming commitment to the current framework and the rise in US rates. It reached JPY136.50 before the weekend, the best level since the December surprise. The JPY136.65 area corresponds to the (38.2%) retracement of the drop since last October's peak (~JPY151.95), and the 200-day moving average is a little above JPY137.00. The momentum indicators are over-extended, and the Slow Stochastic has flatlined slightly below last October's peak. The JPY135 area should now offer support, but it may take a break of JPY134 to suggest a top is in place. The risk in the next couple of weeks may extend toward JPY140.00.
Eurozone: The preliminary February CPI will be reported on March 2. The monthly reading fell for three months through January. The year-over-year pace will likely fall sharply in February and March as the jump (0.9% and 2.4%, respectively) drops out of the 12-month comparison. This and more robust February survey data set the stage for the March 16 ECB meeting. A 50 bp hike has been signaled (lifting the deposit rate to 3.0%), and the key question is what happens in Q2 and Q3. The hawks may push for another 50 bp hike at the May 4 meeting. The terminal rate is seen between 3.50% and 3.75%.
The euro was sold through $1.06 in the second half of last week and traded to about $1.0535 ahead of the weekend. Since $1.07 broke, we have been warning of risk into the $1.0460-$1.0500 area. This still seems reasonable. How the euro responds to the weaker US economic data we expect starting next week may help shape expectations about the extent of a further correction. Note, for example, that the (50%) retracement of the euro's rally from last September's low (~$0.9535) is near $1.0285, and the 200-day moving average is around $1.0330. The $1.06 area may now offer the nearby cap.
China: The February PMI is the economic highlight. The economy appears to be recovering after a particularly weak Q4 22 when the composite PMI was stuck below the 50 boom/bust level. Of note, the manufacturing sector recovery does not seem as robust as the non-manufacturing sector. Weaker foreign demand for Chinese goods is a headwind, and the domestic economy, including construction, has helped lift the tertiary sector. In January, the non-manufacturing PMI was at 54.4 compared with 54.1 on the eve of the pandemic. Note that the National People's Congress's first session is scheduled for March 5. New state appointments will be made. It is at the Congress that Xi will be formally given a third term as president. A new PBOC Governor will also be announced, as will a new party secretary to the central bank.
The yuan is a closely managed currency and officials are not resisting the dollar's upward pressure. The greenback set a new two-month high near CNY6.9600 amid a wider surge ahead of the weekend. The next important area is at CNY7.0, which the dollar has not traded above since February 2. The CNY7.01 area corresponds to a (50%) retracement of the dollar's pullback from the high set earlier last November near CNY7.3275. Weakening exports, the larger discount to the US 10-year yield, and the anticipation of more Fed hikes for longer provide the fundamental fodder.
United Kingdom: Stronger than expected January retail sales (0.5% vs. median forecast in Bloomberg's survey of -0.3%) coupled with an upside surprise in the flash PMI (composite jumped to 53.0 from 48.5, the highest since last June and the first about 50 since last July) provides more fodder for arguments of a short and shallow recession. It also supports ideas that the Bank of England will deliver a quarter-point hike at next month's meeting (March 23) to bring the base rate to 4.25%. The terminal rate is seen at 4.50%, with a slight risk of 4.75%. However, the data in the coming days, primarily about financial variables (January consumer credit, mortgage lending, and money supply), are typically not the stuff that moves sterling.
The outside up day for GBP/USD last Tuesday proved for naught. That was the peak, a little shy of $1.2150, and the drop ahead of the weekend took it to the 200-day moving average ($1.1930). Earlier this month, sterling recorded a low near $1.1915. A break of the January low (~$1.1840) would undermine the medium-term outlook and warn of a potential loss toward $1.1250 (the measuring objective of a possible double top pattern). That said, the (38.2%) retracement of the sterling's recovery from the record low last September is near $1.1650, and the next retracement (50%) is about $1.1400. The $1.2000-50 area may provide initial resistance.
Canada: The Canadian dollar is vulnerable on two counts. First, the Bank of Canada remains the only G10 central bank to declare it is pausing its tightening cycle. The major central banks are not there yet, though several seem one or two hikes away. Second, the Canadian dollar is particularly sensitive to the risk environment, reflected in its correlation with the S&P 500. The rolling 60-day correlation is around 0.73. By comparison, the Australian dollar is the closest, around 0.63, and the yen is about 0.25. The market has not entirely given up on another Bank of Canada hike, perhaps in Q3, but the December and Q4 GDP, the upcoming data highlight (February 28), are unlikely to be very impactful on expectations. The Bank of Canada's March 8 meeting is largely a non-event, but the February employment data on March 10 will draw attention after the dramatic 121k increase in full-time positions in January.
The USD/CAD has risen sharply against the Canadian dollar over the past two weeks. It recorded a low near CAD1.3275 on February 14 and surged to CAD1.3665 ahead of the weekend. Last month's high was set early by CAD1.3685. The December peak was slightly above CAD1.3700, which also marks the (61.8%) retracement of the greenback's downtrend since peaking in the middle of last October (~CAD1.3975). The momentum indicators are getting stretched, but the cautionary signal is that the US dollar closed above its upper Bollinger Band (two standard deviations above the 20-day moving average) found near CAD1.3615. Support is seen in the CAD1.3500-20 band.
Australia: When the Reserve Bank of Australia meets on March 7, it will have Q4 GDP and January CPI (March 1) in hand. It will also see the January trade figures (March 6). The markets favor another 25 bp hike, but it is not completely discounted. The Australian dollar was the weakest G10 currency last week, falling by about 2.25%, bringing the month's loss to nearly 4.75%. It will be the first monthly loss since last October. A possible head and shoulder topping pattern has been formed, though we are less convinced. Yet, the measuring objective would roughly correspond to the (61.8%) retracement objective of the rally off the mid-October low (~$0.6170) that is found around $0.6550. The January low was set on the second trading day of the year, slightly below $.6690. The low set before the weekend was slightly below $0.6810. The lower Bollinger Band is near $0.6735, and the Aussie closed below it for the first time since last July. The $0.6780-$0.6800 may limit initial attempts at recovery.
Mexico: The Mexican peso has performed impressively. It traded at its best level in five years, and pullbacks have thus far been limited. Its 2.25% gain makes the peso the best-performing currency this month and it leads the emerging market currencies here in 2023 with a 5.8% gain. Attractive interest rates and stocks (the Bolsa is up about 8.5% this year, while Brazil's Bovespa is off nearly 3%, and the MSCI Emerging Market equity index is up about 3.4%). Direct investment inflows also appear to be helping to underpin the peso. Mexico reports the January trade balance (February 27), when it typically (past 11 years) deteriorates. It did report its first monthly trade surplus in nine months in December. Worker remittances will be reported on March 1 and remain an essential source of capital inflows, averaging $4.8 bln in 2022 (~$4.3 bln in 2021). The US dollar carved a base last week at five-year lows against the Mexican peso around MXN18.30. Previous support near MXN18.50 has become resistance and checked the greenback's pre-weekend bounce, and once again, the greenback was sold into the modest bounce. A move above the MXN18.53 area could signal a correction toward MXN18.65-MXN18.68. The momentum indicators have stalled in oversold territory. We have not given up on our call for the greenback to test important support around MXN18.00 and the 2018 low (~MXN17.94).
